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Is it all Over for Coal?

July 5, 2013

Many analysts have already put the kibosh on the coal industry soon after Obama’s initiative to cut emissions in the coming years, which will lead to a significant drop in U.S’s coal consumption. But does this mean the coal industry will reach a halt in the near future? Is it time to get out of coal companies such as Arch Coal (NYSE: ACI) and Peabody Energy (NYSE:BTU)?

During 2013, leading coal companies such as Arch Coal and Peabody Energy haven’t done well as their shares tumbled down: Shares of Peabody Energy fell by more than 44% (year-to-date); shares of Arch Coal, by 50%.

Coal consumption in 2013

Despite the bad press coal has been receiving in recent years, coal companies have been making great strides to make coal more environmentally safe.Arch Coal released a statement, in which it is putting efforts to cut down the Co2 emissions of coal consumption. Peabody Energy has also released a similar statement on this issue. In the mean time, coal is likely to remain among the prime sources of electricity in the U.S in the coming years. According to the Energy Information Administrations during the first five months of 2013 coal consumption rose by more than 10% compared to the same time in 2012. Moreover, the EIA also estimates total consumption will rise by 7% in 2013 (year-over-year). This expected growth in consumption is likely to reflect in the revenues of leading coal companies such as Cloud Peak Energy (NYSE:CLD) and Peabody Energy.

Valuation

Following the recent developments in the coal industry, coal companies’ value over long period of time may diminish, assuming the demand for coal will fall in the coming years. Nonetheless, let’s see the current value of leading coal companies. For that end, let’s analyze these companies’ enterprise value and their EV to EBITDA ratio.

The table below shows the valuation of Peabody Energy and Cloud Peak Energy and the average coal industry. I didn’t include Arch Coal because the company isn’t profitable.

This calculation accounts for these companies’ financial structure and not just their earnings and market cap. The yearly EBITDA is based on the last four quarters. Based on the above, Peabody Energy’s EV to EBITDA ratio is higher than the industry average. On the other hand, Cloud Peak Energy has a much lower EV to EBITDA ratio, which is also lower than the industry average. These findings suggest, at face value, that Peabody Energy’s current value is still high, while Cloud Peak Energy’s value is relatively low.

Let’s examine several factors that could affect these companies’ future revenues.

Electricity, natural gas and coal

The recent drop in the price of natural gas is likely to keep utility companies using natural gas and even augmenting their consumption of natural gas over coal.

The chart below shows the developments in the prices of coal and natural gas.

The current price of natural gas is still higher than last year’s price, which may keep coal consumption higher this year compared to 2012. Moreover, as long as natural gas prices are higher than last year, the demand for coal is likely to remain higher than in 2012, which will reflect in the revenues of leading coal companies.

In the coming months the demand for electricity is expected to increase, which will lead to a rise in coal consumption. But the current expectations are that this summer won’t be as hot as last year’s. This could suggest the demand for electricity (mainly for cooling) won’t be as high as last year, which will affect the demand for coal and natural gas.

Exporting coal

The U.S is slowly increasing its coal exports: In the first four months of 2013, coal exports grew by 1% compared to 2012. Moreover, the drop in coal production led to a rise in exports’ share out of total production. Arch Coal also expects coal exports will remain elevated in 2013 and total U.S exports may pass 100 million tons during this year. For Arch Coal, however, the rise in exports is slightly adversely affecting its revenues as price of exported coal is lower than domestic coal price. The same goes for Cloud Peak Energy that had a 10% rise in Asian exports in the first quarter of 2013 (year-over-year). This rise in exports, however, led to a drop in revenues on account of “lower export pricing”. This means, if coal companies will continue to increase their coal export business, their profit margins will be slashed and their revenues won’t rise.

Take away

Coal companies aren’t likely to disappear anytime soon. Their profit margins are likely to keep falling but their total business operations won’t diminish especially as exports continue to rise and natural gas price remains higher than last year’s.

Disclaimer:The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.